#54 | Your Kids Can’t Convert Your IRA to a Roth

Speakers: Jon Gay, Alex Koury, & Bruce Hosler

Jon Gay (00:05):

Welcome back to Protecting and Preserving Wealth. I’m Jon JAG Gay. Alex Koury, and Bruce Hosler from Hosler Wealth Management, join me once again. Hello gentlemen.

Bruce Hosler (00:12):

Good morning, Jon.

Alex Koury (00:13):

Hey, Jon. Good to see you again.

Jon Gay (00:14):

In our last episode we talked about the 10-year rule for beneficiaries, and I encourage our listeners to go back and listen to that episode prior to listening to this episode.

Today we’re talking about the fact that your kids are not going to be able to convert your IRA to a Roth IRA. You must do it yourself. Bruce, how did this topic come about?

Bruce Hosler (00:31):

We’ve had an experience where we had a lady that contacted us, and she said that she had a couple million dollars in her account. She was a little bit more elderly, and her daughter got back to us and said, “Hey, I’m the power of attorney for my mom and we don’t need anything right now. And we’re okay.”

And I got thinking about that and that situation. And I thought, “If you only knew that your mother could start converting this IRA to a Roth while she’s alive, but as soon as she dies, you lose the ability to convert any of that inherited IRA to a Roth at all.”

Even if her mother is not able to convert the whole IRA to a Roth, she could begin to at least convert some of that IRA to a Roth and leave her daughter some of the IRA as a Roth IRA that’s income tax free.

As you all know, I released my book Moving to Tax-Free in March of 2024. And in that book, Moving to Tax-Free, one of the primary tools that we use to help people move to tax-free is the Roth conversion.

And some people have some misconceptions about the Roth conversion, and I’d like to talk about those today. So, Alex, let me ask you a question. What are the limitations? Who is it that can make a Roth conversion? Are there limits and what are those?

Alex Koury (01:58):

So, the answer is there are no limits. There are no age limits when it comes to actually making a Roth conversion. These are dollars that have already been deposited into an IRA or a tax deferred 401(k). So, you have a limited amount of money you can pull from the IRA to convert to the Roth, pay the taxes now and let it grow tax-free.

Bruce Hosler (02:18):

So, you don’t have to be below 59 and a half or above it. You don’t have an income limitation. A lot of people have understood that there’s a limitation on making an IRA contribution. They don’t understand that that does not apply to a Roth conversion. Bill Gates could make a Roth conversion. It doesn’t matter how high your income is.

What happens to your Roth IRA when you die? That’s the next question I have, and I want to apply that to a spouse. And then as the children. So, Alex, a lot of times we know about the spousal rules, they’re special. That’s why we want clients to name their primary beneficiary, their spouse, 100%, not split at 50/50 with the kids or that.

Talk about what usually happens if there’s a Roth IRA, one spouse dies. What are the recommendations? What are the options to that surviving spouse?

Alex Koury (03:10):

So, the best part about the Roth IRA when your spouse inherits that tax-free account is they don’t have any required minimum distributions on a Roth IRA. They could let that grow for the rest of their life and most likely they’re never going to need to touch it anyways.

So, imagine one spouse passes away, the other spouse inherits that Roth IRA, it continues to grow until they pass away, and then the children inherit those Roth IRAs at that point. And then what happens, now the children become the beneficiaries of the Roth IRA.

At that point is when the 10-year clock sets in that those Roth IRA funds must be distributed by the end of the 10th year. Again, as a tax-free benefit to them.

Bruce Hosler (03:53):

So, folks, that is very important. One of the things you need to understand is that there are special rules that apply to spouses and what the special rule is: one spouse can name their spouse as the beneficiary and that beneficiary spouse has the privilege at any time, I might add, to roll that IRA over into their own Roth IRA.

So, they can leave it as the beneficiary and receive income from it as a beneficiary. No required minimum distribution, but probably if they’re still alive, they may be a younger spouse, they have the ability to roll it into their own name since there’s no RMDs on a Roth IRA, then that’s beautiful.

And like Alex said, when they pass away, then their children become the beneficiaries of that inherited Roth IRA.

Now let’s talk about the old stretch IRA rules: what they were and why they no longer apply. In the last segment of the podcast, we talked about how you could leave your IRA to your children, and they could take an RMD over their remaining life. That all went away when the SECURE Act came out in 2020. And now those have to be distributed within 10 years.

Now I want to talk about non-eligible designated beneficiaries. These are primarily beneficiaries that are your children. So, Alex, when you look at the five classes of eligible designated beneficiaries, these are people that have the ability to continue the old stretch IRA rules. Who are the five classes that are included in that eligible designated beneficiary class?

Alex Koury (05:38):

So, the first one, we all know this, would be the surviving spouse. They are considered an eligible designated beneficiary. The second class is going to be minor children of the account owner up until the age of 21, but it can’t be grandchildren. So, it has to be your actual children as a beneficiary under the age of 21.

The third is disabled individuals. And there’s strict IRS rules around this, but they are considered, again, the eligible designated beneficiary. Number four would be chronically ill individuals. And number five is individuals that are older than or not more than 10 years younger than the actual IRA owner.

So, those are your five protected classes of eligible designated beneficiaries. They apply different rules as opposed to the non-eligible designated beneficiaries.

Bruce Hosler (06:27):

Well, all of those eligible designated beneficiaries have the ability to use the pre-2020, so, 2019 and above, the old stretch IRA rules, they can stretch it out and take a required minimum distribution over the rest of their lives.

Folks, the big deal that we’re trying to point out to you is this. Your kids cannot make a Roth conversion from your inherited IRA that you leave to them. Let me say that again. If you leave your IRA to your children, an inherited IRA cannot be converted to a Roth IRA.

So, the only way that you can have your children enjoy the benefits of a Roth IRA is you have to convert this IRA during your lifetime. And if you do not, well, maybe your spouse can if you leave it to him or her.

But if the two of you do not convert, your kids are stuck with a traditional IRA and a 10-year payout and all that tax deferred growth is killed in the 10 years, there’s no tax-free ability for them to make a Roth conversion.

And when we figure this out, this is a big deal. This is a big deal for our clients that have big IRAs. And they think, “Hey, I don’t want to pay the taxes. I’m not going to convert. I’ll leave it to the kids, let them convert, let them pay the taxes.”

Well, guess what folks, if we’re right- and what many of us believe-  is that the tax rates are going to double in the next 10 years, you are leaving your big IRA to your kids at a tax rate that’s twice as high as what you’re paying right now.

Jon Gay (08:12):

I’m going to underline what you just said, Bruce, because Alex ticked off those five groups of protected classes. Adult children were not on that list. So, that’s why this is so important. We’re talking about if you have adult children.

I have had conversations with my folks as they’re getting older, and, “We’re the parent, we want to take care of you, we want to provide for you.” My folks hate it, but if we go to lunch and I pick up the tab, they say, “No, no, no, you’re our kid. You shouldn’t have to do that.”

And what I’m telling my folks now is preparing for the financial future is the best way to provide for your kids as opposed to kicking the can down the road.

Bruce Hosler (08:45):

Absolutely.

Alex Koury (08:46):

What we know is that, today, we’re paying some of the lowest taxes we’ve ever paid. And again, as Bruce mentioned, if we’re right and taxes go higher in the future, well more of your IRAs that are not converted, you’re going to be paying higher taxes on that money.

We typically work with clients starting around 55 and 60-years-old to begin converting their IRA or their 401(k)s or IRAs into Roth IRAs. So, imagine, you’re 60-years-old, you pay taxes now, you might live until 70, 80, 90-years-old. Maybe your spouse outlives you a little longer than that.

Then you’ve got your children that can then take your Roth IRA another 10 more years in a tax-free bucket. That’s potentially 40 years of tax-free growth. And imagine what you can do or what your family can do with that money. Not just your children, but maybe your grandchildren, maybe even future generation can really use that money.

Because again, we don’t know where we’re headed with taxes for the long-term, but we know they’re going to be higher than they’re today.

Bruce Hosler (09:39):

The other point that I want to make at this juncture is folks, if you convert your IRA to a Roth IRA, you do not any longer have required minimum distributions.

Jon Gay (09:52):

Right.

Bruce Hosler (09:53):

They stop. They stop for you. And when you die, they stop for your children, with the exception of at the end of the 10th year, they have to take that Roth IRA out. But you are giving yourself an opportunity to have tax-free income, tax-free growth, and you’re giving your children the same thing without having a required minimum distribution requirement.

Jon Gay (10:19):

Bruce, just to kind of level set for our listeners, are there limitations on the Roth conversions in what you can do?

Bruce Hosler (10:24):

So, folks, there’s no age limitations. There’s no income limitation. So, no matter how much you make or how much you have, you are eligible to make a decision of converting as much as you want in a given year.

Now, many of you know that we like to use the tax bracket strategy, we want to use your tax bracket, we want you to max out your current bracket. We may even want to max out a couple of brackets ahead higher than what you’re currently at, so that you can get your whole IRA converted.

But there’s no limitations on that. You can do this. You can leave this Roth IRA to grow for 10 years after you die and distribute the rest of it at the very end of the 10th year for your children. So, there’s nothing holding you back from doing it.

Now you may feel like, well Bruce, we don’t feel like we want to pay the taxes. Don’t pay the taxes yourself. Let the IRA pay the taxes itself on the conversion. Leave your kids the net, after tax amount. You will be giving them a gift that no one else can give them and they cannot do for themselves.

They cannot convert an inherited IRA to a Roth. Only you can do that. And that’s my message for this podcast. You have to convert the IRA to a Roth. Your children do not have that option. Please take that as the big message from this podcast today.

Jon Gay (11:50):

Folks, you can hear the passion in Bruce’s voice because this is so vitally important when you talk about generational wealth and providing for your heirs, particularly your adult kids in this space. You want to do everything you can to make their life easier.

And that’s why this is so important that adult kids cannot make that Roth IRA conversion if you or your spouse do not do it. I’m so glad we covered this today.

Bruce, Alex, if our listeners want to come talk to you and the team at Hosler Wealth Management about this topic or anything related to their financial future, how do they best find you?

Alex Koury (12:20):

If you want to call the Scottsdale office, if you’re here in the Phoenix area, please give me a call at (480) 994-7342. And for those that are in the Prescott area, you may call the office at (928) 778-7666.

Bruce Hosler (12:35):

And folks, you can certainly catch us on the website at hoslerwm.com. You can schedule appointment right on the website.

Jon Gay (12:44):

Great stuff, really important information. As always, gentlemen, we’ll talk again soon. Thanks.

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Bruce Hosler (12:48):

Thanks Jon.

Jon Gay (12:48):

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